So you’ve done the hard work and saved up some money for your retirement – now what?
The foundation of any successful retirement plan is a solid saving strategy, but it can’t end there. With inflation rates continuously rising (now especially), money in your bank account is likely losing value over time. You need to find a way to make that money work double-time and generate some passive income.
One of the best ways to do this is through investing.
For financial planning newcomers, the word “investing” might seem overwhelming – where do you get started? What risks are involved?
Today, we’re walking you through the two basic building blocks of a healthy approach to investing.
Create a Diverse Portfolio
All investments come with some risk – it’s unavoidable. Luckily, there are strategies you can use to mitigate those risks, such as creating a diversified portfolio.
Diversification is like a vegetable garden. You plant multiple types of veggies with the hope that most will flourish, but the expectation that some of them will struggle from time to time. If you just planted lettuce and then a lettuce-loving pest showed up, your entire crop could be ruined. But if lettuce is only a portion of your garden, you’ll still have plenty of other healthy crops to choose from.
A diverse portfolio spreads your money across several different types of investments or asset classes so if a few of your investments take an unexpected turn for the worse, your portfolio has plenty of other investments to help limit the impact. In the most basic form, portfolio diversification is a practice of balance.
There are two main types of investments we regularly employ here at Clarity to maintain a balanced portfolio: stocks and bonds.
When you invest in equities like stocks, you’re actually purchasing a portion of the company. If you own a share of the stock AAPL, you can confidently say that you are an owner of the Apple company. But that also means that as the company gains profits or debts, your stock’s value changes accordingly.
While purchasing stocks gives you an opportunity to invest and support companies you believe in, they are also considered a riskier investment than bonds.
For example, stock values tend to fluctuate with world events. With recent world events including the Russian invasion of Ukraine and the seeming (fingers crossed) end of the pandemic, some tech companies like Peloton and Roku are down 75% from their 2021 highs.
Unlike stocks, bonds are a form of fixed income. Bonds are like a loan that you give to a company or the government – they promise to pay you back by a specific time, with an agreed-upon amount of interest on top of that.
For example, you could ask your broker to buy you a municipal bond from your state of residency. Usually, you would need a minimum $5,000 for this investment. This is generally considered a safer move than investing in stocks – while bonds can also fluctuate in value with world events and inflation, there is less overall volatility.
In 2021, bonds took a turn downward, with many posting negative returns. While this may be concerning to some investors, it’s worth pointing out that it’s historically rare for there to be two negative-return years in a row in the bond market.
While the potential gains are more limited with bonds than with equities, so are the losses. To get the best of both worlds, a diversified portfolio will contain a unique blend of both stocks and bonds.
The Importance of Asset Allocation
Asset allocation is about building the right ratio of stocks to bonds so your portfolio is aligned with your personal goals and risk profile. In general, asset allocation is measured in a range from “conservative” to “aggressive.”
The main goal of a conservative portfolio is to protect the money you already have – it’s all about reducing risk. Of course, invest too conservatively and your portfolio could lose value over time due to inflation.
On the other hand, aggressive portfolios are all about taking on risk to gain as much money as possible. But aggressive investments are often volatile – so their values shift from day to day. Aggressive portfolios are usually employed as a long-term investment strategy.
Of course, you don’t have to just choose between conservative or aggressive – there are a plethora of options in between the two. Asset allocation is the practice of finding that perfectly unique balance that matches up with your own individual goals.
If you’re comfortable with a lot of risk and/or have more aggressive goals, then your portfolio will probably be heavier in stocks than bonds. If you are especially risk-averse and want to invest conservatively, then you may go heavier on bonds.
We usually recommend more equities for younger investors as they have more time to keep their money in the market, and typically have a higher risk tolerance. For clients approaching retirement – a time when you want to avoid big drops in the value of your portfolio – fixed income investments tend to be a safer bet.
Grow Your Savings with Clarity
Are you ready to start your investment journey? Reach out to Clarity Wealth Development today to speak with a financial advisor and get on track for your unique retirement goals.